Biggest Takeover Profit Beckons Arbitragers to Medco: Real M&A

While Medco’s stock climbed more than $10 in the two days following the Express Scripts deal, it has lost about half the gain since July 22. Photographer: Emile Wamsteker/Bloomberg

Aug. 3 (Bloomberg) -- Traders willing to bet that Express
Scripts Inc.’s $29.1 billion offer for Medco Health Solutions
Inc. can win antitrust approval now have a chance to earn the
biggest profit of any takeover in America.

Medco rose 18 percent after Express Scripts said July 21
that it would buy the company to create the largest U.S. manager
of prescription drug benefits. The stock has since fallen seven
consecutive days on concern U.S. regulators will block the
acquisition. With Medco of Franklin Lakes, New Jersey, trading
more than $10 below the cash-and-stock offer valued at $70.64 a
share, traders can reap a 17 percent gain betting the deal will
close, according to data compiled by Bloomberg.

While Medco investors are growing more skeptical the
Express Scripts bid can withstand scrutiny from the U.S. Federal
Trade Commission, merger arbitrage analysts at Oscar Gruss & Son
Inc. and Tullett Prebon Plc say the windfall now outweighs the
risk that the deal will fail or be delayed. Express Scripts,
which would control about 30 percent of the drug benefits
business, will have more leverage to negotiate lower consumer
prices from drugmakers without dominating a market where rivals
would still manage plans for seven of every 10 insured Americans,
according to BB&T Capital Markets and Stifel Financial Corp.

“Investors can profit,” Bill Kavaler, a New York-based
special situations analyst at Oscar Gruss, said in a telephone
interview. Pharmacy benefits managers are “the only ones in the
health-care industry that are in the position to negotiate
effectively with the pharmaceuticals to lower drug prices,”
which makes the FTC less likely to delay the sale, he said.

“I believe that it will get done,” he said.

Acquisition Detail

Brian Henry, a spokesman for St. Louis-based Express
Scripts, said the company expects to undergo the regulatory
review process and referred to its statement with Medco on July
21. Lowell Weiner, a spokesman at Medco, declined to comment and
also referred to the joint statement.

“Express Scripts and Medco believe they will be successful
working through the regulatory review process,” the statement
said. The pharmacy benefits management, or PBM, “business will
continue to remain competitive after this transaction,” it said.
The companies expect the acquisition to close in the first half
of 2012, according to the statement.

Mitch Katz, a Washington-based spokesman for the FTC,
declined to comment on whether the agency has begun a review of
the acquisition.

Express Scripts will pay Medco holders $28.80 a share in
cash and 0.81 Express Scripts share for each Medco share held,
the companies said in their July 21 statement.

Deal Spread

Including net debt, the acquisition was valued at $34.3
billion, data compiled by Bloomberg show. At the time the deal
was announced, the agreement was about 28 percent higher than
Medco’s price of $55.78 a day prior to the offer.

While Medco’s stock climbed more than $10 in the two days
following the Express Scripts deal, it has lost about half the
gain since July 22. Medco closed at $60.46 yesterday, $10.18
below the current value of Express Scripts’ offer, according to
data compiled by Bloomberg.

The difference between Medco’s price and the deal offer is
now the widest of any pending cash-and-stock deal in the U.S.,
indicating the acquisition offers the biggest arbitrage profit
as well as the highest likelihood of failure of any comparable
deal, data compiled by Bloomberg show.

“The spread is very big,” Eugene Goldenberg, an analyst
at BB&T Capital in New York, said in a telephone interview.
“It’s actually the largest spread I have seen” in at least
five years, he said. “My gut sense right now is about a 60/40
that it will pass.”

Antitrust Concern

Medco has declined on concern the acquisition, which would
exceed the $21.7 billion deal that formed CVS Caremark Corp. in
2007 as the largest in the industry, won’t gain approval or will
be held up as the FTC reviews possible anti-competitive aspects
of the agreement, Goldenberg said.

The agreement would create a company with more than $115
billion in revenue next year, according to analysts’ estimates
compiled by Bloomberg. Together, the two largest companies that
handle drug benefits for corporate and government clients will
have a 28 percent share, according to BB&T Capital.

Woonsocket, Rhode Island-based CVS Caremark would become
the second-largest U.S. manager of pharmacy benefits with a 19
percent share. It had $48 billion in sales from that part of the
business last year, data compiled by Bloomberg show.

‘Question Marks’

“The federal government has historically embraced the PBM
industry,” Steven Halper, an analyst at Stifel in New York,
said in a telephone interview. Still, “there’s three big ones
going into two. That will always raise question marks at the FTC
regardless of historical precedent.”

Oscar Gruss’s Kavaler said the deal will probably win
regulatory approval because Express Scripts and Medco negotiate
with pharmaceutical companies for lower prescription drug prices,
which benefit consumers. By having the largest client base, the
combined entity would be better able to extract bigger discounts
from drugmakers that already provide their products to other
managers at reduced prices, he said.

That makes Express Scripts and Medco the “good guys” as
the government aims to lower health-care costs, he said.

Minnetonka, Minnesota-based UnitedHealth, which didn’t
renew its pharmacy benefits contract with Medco last month, will
itself control an 11 percent share after Express Scripts’
takeover of Medco closes, according to BB&T Capital.

Price Competition

The companies will argue Medco is mostly national accounts
and Express Scripts is more local and small businesses, and that
UnitedHealth is going to be a strong No. 3 behind CVS Caremark,
a person familiar with the agreement, who declined to be
identified because the discussions were private, said last month.

“When you look at the data points this industry is
fiercely competitive, and it’s all on the basis of price,” said
Helene Wolk, an analyst at Sanford C. Bernstein & Co. in New
York. Because of the deal, “the industry gets more concentrated
but not enough. It remains price competitive.”

The health-care industry is also under increased pressure
to reduce medical expenses after a debt-ceiling agreement this
week required spending cuts on Medicare, the federal health
program for the elderly and disabled. That will create demand
from the government for larger benefits managers that can win
the biggest price reductions for prescription drugs and spur
more acquisitions within the industry, according to Sachin Shah,
the Jersey City, New Jersey-based special situations and merger
arbitrage strategist at Tullett Prebon.

“It’s overblown in the antitrust perspective,” he said in
a telephone interview. “I am still bullish on them getting
ultimate approval.”